DST Investment Advisors
Tenants-In-Common (TIC)
Tenants in Common in Real Estate
Real estate offers a spectrum of potential advantages for both newcomers and seasoned investors. They have the potential to generate regular rental income and profit from property appreciation if property values increase during their ownership. Investors can also defer capital gains taxes through 1031 exchanges and benefit from substantial depreciation deductions when filing their annual tax returns.
In the article below, we’ve explored various aspects of an investment strategy employed by investors to acquire fractional ownership in a diverse range of real estate assets. The Tenant-In-Common (TIC) arrangement allows investors to participate in a co-ownership pool, enabling them to access properties that might otherwise be out of reach for individual investors. TIC opportunities are often pre-packaged by a sponsor and include professional property management. Financing may also be prearranged, streamlining the process of identifying, acquiring, financing, and closing on a TIC property for a 1031 exchange.
Investors contemplating this ownership structure for completing a 1031 exchange should seek guidance from qualified accounting and tax professionals to ensure compliance with crucial IRS regulations and deadlines.
What is a Tenant in Common?
Tenant-In-Common, abbreviated as TIC, represents a legal ownership structure in which multiple investors engaged in 1031 exchanges jointly own individual undivided interests in real estate assets. These owners can possess varying ownership shares, and they retain the ability to independently sell or mortgage their interests without involving other co-owners. It’s important to note that co-owners are not actual tenants residing in the properties; the term “tenants” refers to the occupants leasing the property.
TICs are subject to specific IRS regulations that investors must adhere to in order to qualify for the tax-deferred benefits associated with a 1031 exchange. A primary requirement is that taxpayers must reinvest the proceeds from the sale of real property into like-kind assets; these benefits do not apply if the proceeds are reinvested in REITs, partnerships, or LLCs.
Additional IRS guidelines for Tenant-In-Common arrangements include:
- Co-owners must share costs related to debt servicing and other expenses based on their pro rata shares — same with income distributions. Only the parties listed on title can receive profits or pay for expenditures.
- The number of co-owners is capped at 35.
- TIC sponsors can’t be compensated through income or returns to investors.
- All decisions regarding material usage must be unanimously approved by all co-owners.
Another significant facet of Tenant-In-Common (TIC) arrangements is that co-owners have the ability to pass on their ownership shares to a selected heir upon their demise.
Why Choose a Tenant-In-Common Arrangement for a 1031 Exchange?
Experienced investors often utilize 1031 exchanges as a strategy to defer capital gains taxes when selling real property by reinvesting the proceeds in like-kind assets. A Joint Tenants-In-Common exchange occurs when multiple owners share fractional interests in a property acquired through the 1031 exchange process.
There are several compelling reasons why investors might find this option attractive. With the potential for up to 35 investors, the minimum investment requirements can be significantly lower for individual participants. Additionally, the investment amounts can be flexible since co-owners can hold varying ownership percentages.
The reduced minimum investment thresholds also enable individual investors to diversify their investment capital across multiple properties and diverse asset classes. This diversification can be crucial for mitigating the impact of regional market fluctuations. Furthermore, having a group of investors offers a broader pool of resources for various property management decisions, lease negotiations, and other essential aspects of property ownership, reducing the burden of sole responsibility.
How are TICs Different From Joint Tenants in Common?
In a Tenant-In-Common (TIC) arrangement, co-owners collectively possess fractional shares of a property. Conversely, a Joint Tenancy-In-Common involves a partnership where investors hold equal interests in an asset. To establish a Joint Tenancy-In-Common, owners must satisfy the following “unity” criteria:
- Undivided right to possession
- Equal interests
- Ownership is acquired simultaneously
- Each owners name is listed on the deed
A significant distinction between TICs and Joint Tenancy-In-Common ownership pertains to the disposition of shares upon a co-owner’s death. In a TIC, you have the option to pass your interests on to your heirs. In a Joint Tenancy-in-Common, when a partner passes away, their shares automatically transfer to the remaining partners through “rights of survivorship.” Each approach has its advantages and disadvantages. On one hand, surviving owners in a Joint Tenancy in Common avoid the lengthy probate process and seamlessly absorb the departed partner’s shares. Conversely, they are unable to pass on their ownership shares to a chosen heir.
Additionally, within a Joint Tenant-In-Common, all owners must unanimously agree to sell their shares simultaneously; individual partners cannot exit the Joint Tenancy ownership arrangement prematurely.
How is a Tenancy-In-Common Different From a Delaware Statutory Trust?
TIC arrangements exhibit some resemblances to Delaware Statutory Trusts (DSTs). Both permit fractional investments and are eligible for use in a 1031 exchange. Nevertheless, there exist significant distinctions between them, including:
Passive Ownership:
DSTs are under the professional management of a property manager and the DST sponsor, relieving owners of involvement in daily asset operations.
In TICs, all owners must unanimously vote on critical property management decisions, which are then executed by the TIC sponsor or property manager.
Number of Investors:
A Tenant-In-Common can have a maximum of 35 individual investors, while there are no constraints on the number of investors who can hold fractional interests in a Delaware Statutory Trust.
Financing:
Debt incurred in a DST is assumed by the trust itself, not individual investors, as the trust holds title to the property. Consequently, DST investors do not report mortgage payments on their financial statements.
Conversely, in a TIC, each co-owner holds title and is responsible for making mortgage payments. This aspect often makes securing financing for a Tenant-In-Common arrangement more challenging since each owner must gain approval from a lender.
Investment Requirements:
In a TIC, ownership is restricted to 35 investors, potentially necessitating larger individual investment amounts when acquiring high-value assets.
DSTs do not have a limit on the number of investors, generally resulting in lower minimum investment requirements. Tenant-In-Common investments may necessitate a $500,000 investment stake, in contrast to $100,000 for a DST.
1031 Exchange Execution:
Both ownership structures qualify for like-kind exchanges involving equal or greater debt. However, DST exchanges can be more straightforward to complete due to investors having lower financing ratios with non-recourse debt.
Pros of Investing in a Tenant-in-Common Property
Numerous investors opt for 1031 exchanges into Tenant In Common properties as a strategy to postpone capital gains taxes following the disposal of a real estate asset. Beyond the advantages mentioned earlier, there exist several compelling rationales for investors to contemplate engaging in a 1031 exchange into a TIC structure:
Timing and Preparation: Compliance with IRS regulations for a 1031 exchange is crucial. Investors are granted a 45-day window to pinpoint a suitable like-kind replacement property and a 180-day timeframe to finalize their new investment. Sponsored TIC properties streamline and hasten this procedure in various ways. The sponsor has already conducted all necessary due diligence, including inspections, financial assessments, and rent roll evaluations. Financing arrangements are also prearranged.
Depreciation Benefits: Investors can capitalize on annual depreciation deductions, deferring them on their tax returns.
Potential Ongoing Income: Tenant lease payments are regularly disbursed to TIC property owners, with funds being directly deposited into their bank accounts on a monthly basis, as applicable.
Diversification Opportunities: Investors have the option to exchange into multiple properties, fostering diversification within their portfolios across different asset types and geographic regions.
Minimal Expenses and Fees: Most TIC investment properties come with minimal associated fees, as sponsors have already handled appraisals, reports, and other essential investment documentation. Additionally, closing costs are typically not part of the exchange process.
Cons of Investing in a Tenant-in-Common Property
While TIC properties offer numerous enticing investment advantages, it’s important to acknowledge that there are also certain disadvantages associated with the Tenant in Common arrangement. These drawbacks encompass:
Shared Ownership and Decision-Making: Significant operational choices regarding a TIC property necessitate unanimous agreement among all co-owners. This could present challenges if investors possess distinct goals, objectives, or perspectives regarding the property’s management and operation. Unanimous consent is also mandatory for co-owners to initiate property sales or refinancing, as well as for approving new leases or engaging new management services.
Cost: The sponsor responsible for packaging and coordinating the TIC will receive a percentage of the investment funds for their services. Similarly, licensed brokers who sell TIC shares to the pool of investors receive compensation.
Investor Limits: The imposition of a 35-member cap on investors can significantly raise the minimum equity required by co-owners, especially for higher-quality assets that command premium prices. However, because TIC shares can be held in varying proportions, key investors may choose to contribute larger sums in accordance with their investment strategies.
Financing: Securing financing can be challenging in a TIC arrangement since each co-owner is also a co-borrower on the property. Many lenders opt to avoid this ownership structure due to the complexities involved in the associated paperwork.
Control: No single investor among the Tenants in Common owns the property outright. If one co-owner has a lien or judgment filed against them, it could have adverse repercussions for other co-owners.
Illiquidity: Although Tenant in Common interests can be sold without requiring approval from other owners, there may be an existing agreement that grants a right of refusal. Likewise, finding buyers for your interests might prove difficult due to a limited pool of potential purchasers.